I warned many about the coming crisis, long before it happened, on many occasions and in many places, even at the World Bank. They did not want to listen and that´s ok, it usually happens, but what is not ok, is that they still do not seem to want to hear it. “We can easily forgive a child who is afraid of the dark; the real tragedy of life is when men are afraid of the light.” (Plato: 427 BC – 347 BC)

Sunday, September 27, 2009

Do you believe that the capacity of a client to repay his debt to a bank is so important to the health of the financial system and the economy so that you should not have any other concern than measuring the risk of default?

Do you believe that risk of default could be defined and measured in such a consistent way so as to be used for establishing different capital requirements for banks?

Do you believe there are credit rating organizations capable to resist being captured by those rated even if their ratings are used for establishing the capital requirements of banks?

If you decide to use different capital requirements for banks dependent on credit ratings will this be sufficiently transparent for the markets and not distort their risk allocation mechanism?

As a financial regulator do you see it your duty to stop any bank from defaulting?

Our financial regulators answered yes to all questions above and that is why we are in a mess. What is most incredible is that we allowed our financial regulators to elaborate and correct their exam themselves. From their answers anyone should have been able to see they were not ready to be financial regulators.

Wednesday, September 16, 2009

Even if the credit ratings are absolutely right, using them as they are used, as a basis for calculating capital requirements of banks, is wrong, because the regulators have no business introducing an arbitrary regulatory bias against risk-taking. The world moves forward taking risk, the world lies down and dies avoiding risk.

“The First Pillar” of our current bank regulations (Basel) establishes the “Minimum Capital Requirements” for the banks (MCRs).

The MCRs depend on a risk assessment of a quite vaguely defined risk of default. The risk assessment is to be carried out primarily by the Credit Rating Agencies but, in the case of larger banks, also by using their internal risk models. In this respect, as an example, the MCRs rule that if a bank lends to an ordinary not rated client, it is required to hold 8 percent in equity, which is equivalent to an authorized leverage of 12.5 to 1, but, if lending to a client that is rated AAA, then it only needs to hold 1.6 percent in equity, which is equivalent to an authorized leverage of 62.5 to 1.

The above represents two risks, both clearly evidenced in the current crisis.

The first is that the credit rating agencies, by being captured by other interests or plainly because of human fallibility, could be wrong in their assessments, with the consequences that too much capital will follow the wrong ratings in the wrong direction. The current crisis did not result from investment in anything that could be considered as risky but almost exclusively from investments in instruments carrying an AAA rating and which were considered to be absolutely free of risk.

The second risk with the structure of the MDCs is that they effectively imply a subsidy to anything perceived as having a low risk and, comparatively, a tax on whatever seems to carry a higher risk. The subsidies, or costs, of these regulatory risk-weights, are layered on whatever risk differentials the market already prices in their interest rate spreads. This creates confusion in the risk allocation mechanism of the market as the signals are obscured and no one knows for sure whether the low spreads are the result of low risks or the result of low capital requirements. But, so much worse, these risk-subsidies or risk-taxes help to channel and push capital flows into “risk-free” territories that could already be swamped or serve no real societal purpose, or stop capitals from flowing into dried areas much in need of capitals and which represent important societal purposes.

All human endeavors to move forward are risky by nature, and there is absolutely nothing that in economic terms justifies a regulatory bias in favor of what is perceived as having a low risk. In the current crisis immense amounts of capital were lost sustaining a useless and artificial housing boom in a developed country, and not lost in projects that for instance tried to combat climate change or create sustainable jobs.

The Gini Coefficient, in economics, measures the inequalities in the distribution of wealth and income, from cero, no inequalities, to 1, absolute inequality. The current bank regulatory system, by design, with the MDCs pushes up the world’s Gini Coefficient. Do we really want that?

Please help us mend the faulty core of our bank regulations. Without this, all our other important and needed efforts to reform our financial sector are meaningless.

Wednesday, September 9, 2009

One of the most serious threats to development, both in developing and developed countries, is the castration of our banks by the Basel Committee by means of the minimum capital requirements for banks based on assessments of default-risk.

The real stability of a financial system does not depend so much on avoiding the risk of defaults but on making sure that the underlying growth of the economy in which the banks function is healthy and sustainable as a whole. In this respect, imposing “risk-weights”, could quite plausibly elevate the risks of getting the wrong sort of growth in which not only the banks would fail but also the rest of the economy.

The default-risk based capital requirements for banks have effectively imposed a tax on all lending to what is perceived by credit rating agencies as more risky, notwithstanding that these loans could be the most productive for the society; and effectively introduced a subsidy to anything that can dress up as having a low risk, notwithstanding that these loans could be the most unproductive for the society.

The default-risk based capital requirements for banks are effectively increasing the world’s Gini coefficient.

Therefore, if the wimps of the Basel Committee absolutely insist on discriminating between borrowers with their “default-risk weights”, then the society should at least have the right to request the introduction of some “loan-purpose weights” as counterweight to the risk-adverse maniacs.

Over the last years (2004-2007) trillions of dollars of funds, more than the World Bank and the IMF have lent altogether since they were created over sixty ago, were diverted, by the false AAA signs set up by the credit rating agencies, to finance an artificial housing boom. Had it not been for those signs much of those funds could have gone for instance to solve bottleneck problems in the infrastructure in developed and developing countries; to create decent jobs in developed and developing countries alike; or to help fight climate change.

Think of it, don’t you see that if the AAA ratings of the subprime mortgages had been absolutely correct then we could be on our way to something even more disastrous, as the world concentrated more and more all its scarce financial resources in the building and the revaluing of houses in the USA.

Friend, please act now and help us recover our banks.

And also, please stop calling what detonated because of investments in the supposedly safest assets, mortgages and houses, in the supposedly safest country, the USA, and in the supposedly safest instruments, those rated AAA, a financial crisis resulting from excessive risk-taking. It is a financial crisis caused by an excessive and completely misguided risk-aversion.

Tuesday, September 8, 2009

If the regulatory principles involved had been right then the proposal would represent a quite reasonable to good tweaking of the current regulatory system. Unfortunately since the underlying regulatory principle is wrong the tweaking will not achieve the results that are needed.

The real stability of a financial sector does not depend so much on avoiding the risk of individual banks failing, but on making sure that the underlying growth of the economy in which the banks function, is healthy and sustainable as a whole.

In this respect introducing regulatory biases in favor of risk-aversion could quite plausibly elevate the risks of getting the wrong sort of growth in which not only the banks would fail but also the rest of the economy.

Therefore if the regulators absolutely insist on discriminating between borrowers with their “risk of default weights” then the society should at least have the right to request the introduction of some “purpose weights” as counterweight to the regulator’s extreme risk adverse bias.

Most of the problem we encounter with the reform derives from the fact that most still believe that this crisis resulted from some excessive risk-taking, even when staring at the evidence that most of the losses resulted from trying to earn a couple of more basis points investing in AAA rated securities. The day regulators are able to see it as it is, the result of a misguided risk-aversion, much of it induced by the regulators, that day we stand a better chance for a better reform of our financial sector.

Saturday, September 5, 2009

Paul Krugman in "How Did Economists Get It So Wrong?", September 6 writes “There was nothing in the prevailing models suggesting the possibility of the kind of collapse that happened last year”

Absolutely not! Paul Krugman, in relation to the financial crisis, has no idea of what he is talking about. The collapse was doomed to happen, courtesy of the financial regulations in place.

In January 2003 the Financial Times published a letter I wrote and that ended with “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friends, please consider that the world is tough enough as it is.” http://bit.ly/5i1Bu

Also, in February 2000 in the Daily Journal of Caracas in an article titled “Kafka and global banking” I wrote the following:

A diminished diversification of risk. No matter what bank regulators can invent to guarantee the diversification of risks in each individual bank, there is no doubt in my mind that less institutions means less baskets in which to put one’s eggs. One often reads that during the first four years of the 1930’s decade in the U.S.A., a total of 9,000 banks went under. One can easily ask what would have happened to the U.S.A. if there had been only one big bank at that time.

The risk of regulation. In the past there were many countries and many forms of regulation. Today, norms and regulation are haughtily put into place that transcend borders and are applicable worldwide without considering that the after effects of any mistake could be explosive.

Excessive similitude. By trying to insure that all banks adopt the same rules and norms as established in Basle, we are also pushing them into coming ever closer and closer to each other in their way of conducting business. Unfortunately, however, nor are all countries the same, nor are all economies alike. This means that some countries and economies necessarily will end up with banking systems that do not adapt to their individual needs. http://bit.ly/HIi3x

Truth is only some PhD regulators who have never ever stepped outside their offices to walk the real streets of finance could have been as naïve and gullible to believe they could empower the credit rating agencies so much to determine the financial flows without setting them up to be captured.

The sooner the world stops the financial regulations from falling excessively in the hands of the PhDs the better and this, of course, does not mean that I do not recognize the importance of the PhDs.

And, by the way, I am an economist… only that I have walked the streets as a professional for over 30 years.

Wednesday, September 2, 2009

The minimum capital requirements for the banks drafted by the Basel Committee and that apply or inspire most bank regulations in the world establishes that if a bank gives a loan to a normal entrepreneur who does not have a credit rating then it needs 8 percent in capital; if the loan is to a client with an AAA rating then 1.6 percent in capital will do and if it is a loan to its government then there is no capital requirement at all.

Dear libertarians/conservatives.

Eight percent in capital when lending to a citizen and zero when lending to the government…does this not upset you?

Is not risk taking what keeps a society moving forward? Is not taxing risks and subsidizing risk adverseness something like having your country lie down and die?

Do you not find it crazy that some few credit rating agencies, even if private, shall have so much to say in orientating the capital markets and messing up the risk allocation systems?

Dear progressives.

Eight percent in capital when lending to an ordinary citizen and 1.6 percent when lending to a company rated AAA… do you agree with such discrimination? Does not the AAAristocracy have enough advantages already?

Don´t you know that AAA ratings in just a couple of years drove more capitals to the US housing market than all the loans given by the World Bank and the IMF ever since they were founded? How come you can applaud silly initiatives like Banco del Sur when obviously a Credit Rating Agency del Sur seems to carry so much punch nowadays?

Low capital requirements just because someone has got an AAA rating and is supposedly risk free… and what about the purpose of the loans should not that count too?

Dear middle of the roaders.

All of the above plus:

Think about it, even if the credit rating agencies had been perfectly right in their assessments what would the country have gained… more mortgages to ever bigger houses?… more financing from abroad in order to keep on buying even more imports?

The way you kids growing up with GPS might never know what north, south, east and west means… do you want your bankers just to follow credit rating agencies opinions and never learn themselves about analyzing a client, looking him in the eyes and shaking his hand?

Do you really want to have your financial sector watched over by regulators so naive and gullible that they did not know that sooner or later the credit rating agencies that they empowered so much would be captured?

No, all of you think tanks!… what´s wrong with you?…. Too lazy to even read the Basel Epistles that governs most of your current financial regulatory system? As a fact, from all of the books articles comments and other ways of expression we see from those selling themselves as experts on the crisis, there is clear evidence that 99 percent of them have not even read an abridged version of what is contained in Basel II.

Or are you all just a bunch of baby-boomers who follow whoever promises most to avoid risks, while you are around, placing your reverse mortgage of the world and shouting “Après nous le deluge”? If so, shame on you all!

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Why don't bank regulators get it?

The less the perceived risk of default is, and the higher the leverage allowed, the greater the systemic risk.

My huge problem!

Q. "If Kurowski is right, why are his arguments so ignored? A. If I had argued that the regulators were 5 to 10 degrees wrong, I would be recognized, but since I am arguing they are 150 to 180 degrees wrong, I must be ignored.

The deafening noise of the Agendas

The fundamental reasons why it is so hard to advance the otherwise so easy explainable truth of this financial crisis, is because of the deafening noise of the Agendas…

On one side, we have the "progressives" who want to put all the blame on capitalistic banksters, and, on the other, the "conservatives" who want to blame the socialistic government sponsored enterprises GSEs of Fanny Mae and Freddy Mac.

For any of both sides accepting the fact that it was mostly a regulatory failure of monstrous proportions would seemingly be a highly inconvenient truth that would not help them to advance their respective agendas.

You tell me!

What is more dangerous in a systemic way, that which is perceived as risky or that which is perceived as not risky? Right!

How can the Basel Committee be so dumb?

Systemic risks is about something that can become as big so as to threaten the system… and our bank regulators in the Basel Committee are incapable or unwilling to understand that what has the largest possibilities of growing as big so as to threaten the system is what is perceived as having little or no risk, not what is perceived as risky… which makes their first and really only pillar of their regulations, that of capital requirements of banks that are lower when perceived risks are lower… so utterly dumb!

We must stop our gullible and naive financial regulators from believing in never-risk-land.

The stuff that bonuses are made of

Whenever a credit rating corresponds exactly to real underlying risk neither borrower nor lender loses but the intermediary cannot make profits… it is only when the credit ratings are too high or too low that those margins that can generate that profitable stuff that bonuses are paid for exist.

What were they thinking?

The default of a debtor is about the most common, natural and even benign risk in capitalism, so it is so hard to really get a grip on what was going around in the minds of the regulators when they decided to construe capital requirements for banks based exclusively on discriminating against that risk as it was perceived by some credit rating agencies.

Day by the day it is becoming more relevant... scary!

This I published in November 1999... Read it!

The possible Big Bang that scares me the most is the one that could happen the day those genius bank regulators in Basel, playing Gods, manage to introduce a systemic error in the financial system, which will cause the collapse of the OWB (the only bank in the world) or of the last financial dinosaur that survives at that moment.

Currently market forces favors the larger the entity is, be it banks, law firms, auditing firms, brokers, etc. Perhaps one of the things that the authorities could do, in order to diversify risks, is to create a tax on size.”

This I wrote, October 2004, as an Executive Director of the World Bank

We believe that much of the world’s financial markets are currently being dangerously overstretched through an exaggerated reliance on intrinsically weak financial models that are based on very short series of statistical evidence and very doubtful volatility assumptions.

Regulatory hubris

In a world with so many different risks, some naïve gullible and outright stupid regulators thought everything would be fine and dandy if they just had some few credit rating agencies determine default risks and then gave the banks great incentives, by means of different capital requirements, to follow those credit risk opinions.

On bs.

When experts bs..t the world that’s bad news, but when experts allowed themselves to be bs..ted by bs..ing experts that’s is when the world goes really bad.

My most current proposal on the regulatory reform for banks

Fire the teachers!

They were supposed to teach the world prudent risk-taking and instead they taught it imprudent risk-aversion.

The deal!

This was the deal! If you convinced risky and broke Joe to take a $300.000 mortgage at 11 percent for 30 years and then, with more than a little help from the credit rating agencies, you could convince risk-adverse Fred that this mortgage, repackaged in a securitized version, and rated AAA, was so safe that a six percent return was quite adequate, then you could sell Fred the mortgage for $510.000. This would allow you and your partners in the set-up, to pocket a tidy profit of $210.000

Calling it quits?

A world that taxes risk-taking and subsidizes risk adverseness is a world that seems to want to lie down and die

Let´s neutralize the wimps!

If we are to keep on using Basel methodology for establishing the minimum capital requirements for banks, beside better risk weights, we must demand it also uses “societal purpose” weights.

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Silly bank regulators!

What other word could describe a bank regulatory system designed exclusively to avoid bank crisis as if that is the only purpose of banking. You might just as well order the kids to stay in bed all life so as to diminish the risk of them tripping.

The minimum capital requirements of Basel that are based on default risks as measured by the credit rating agency amount to a dangerous tax on the risk, the oxygen of development.

Blindly focusing on default and leaving out any consideration that a credit with a low default risk but for a totally useless or perhaps even an environmentally dangerous purpose is much more risky for the society than a credit with a higher default risk destined to trying to help create decent jobs or diminish an environmental threat, is just silly.

But do I have to be disrespectful and call them silly? Well, individually perhaps they are not, but, as a group, bank regulators are so full of hot air that someone has to help them to puncture their cocoon balloon and let them out.

Breathe!

I’m going to third-pillar what?

By now the desperate bank regulators are throwing at us the third pillar of their Basel regulations which implies the need that we ourselves privately monitor our banks. Great, in my country, a couple of decades ago, I did just that and had a fairly good grip on whom of my banker neighbors were good bankers and whom to look out for.

But sincerely what am I supposed to do know when about 50 per cent of the retail deposits in my country are in hand of international banks (Spain) and that might be losing their shirt making investments in subprime mortgages in California?

Tragedy!

It is very sad when a developed nation decides making risk-adverseness the primary goal of their banking system and places itself voluntarily on the way down but it is a real tragedy when developing countries copycats it and fall into the trap of calling it quits.

Development rating agencies?

A bank should be more than a mattress!

When considering the role of the commercial banks should not the developing countries use development rating agencies instead of credit rating agencies?

Clearly more important than defending what we have is defending what we want to have.

What do we want from our banks?

Over the last two decades we have seen hundreds if not thousands of research papers, seminars, workshops conferences analyzing how to exorcize the risks out of banking; and if in that sense the bank regulation coming out from Basel was doing its job; and centred around words like soundness, stability, solvency, safeness and other synonyms. Not one of them discussed how the commercial banks were performing their other two traditional functions, namely to help to generate that economic growth that leads to the creation of decent jobs and the distribution of the financial resources into the hands of those capable of doing the most with it.

At this moment when we are suddenly faced with the possibilities that all the bank regulator’s risk adverseness might anyhow have come to naught, before digging deeper in the hole where we find ourselves fighting the risks, is it not time to take a step back and discuss again what it is we really want our commercial banks to do for us? I mean, if it is only to act as a safe mattress for our retail deposits then it would seem that could be taken cared of by authorizing them only to lend to the lender of last resort; but which of course would leave us with what to do about the growth and the distribution of opportunities.

About Me

We are suffering from more and more answers than questions begging for them, and so I work on the latter.
Read it all in my one and only book!"Voice and Noise"
Pssst... so few have read this book so it is slowly turning into a collector item (I do not say a "cult"... yet) and so you might benefit from getting your very own copy now.